SMALL FINANCE BANKS (SFB) IMPORTANT TOPIC | IIBF CERTIFICATION STUDY MATERIAL
This article will talk about risk management which is an important topic of Small finance banks (SFB). Here we try to help you understand the function of risk management, its structure, types of risks, loan review mechanism and basel norms etc.
Banks in the process of financial intermediation must identify, measure, monitor and control risks associated with credit, interest rate, foreign exchange rate risk, liquidity risk, equity price risk, commodity price risk, legal risk, regulatory risk, reputation risk and operational risk.
These risks are highly inter-dependent/inter-dependent events that the banks/financial institutions and must be identified, measured, monitored and controlled. The latest provisions applicable to scheduled commercial banks and SFBs will apply to SFBs as well.
Risk management: Function | SFB IMPORTANT TOPIC
Risk management should be based on organizational structure, comprehensive risk measurement approach, policies approved by the board, guidelines and parameters used to govern risk taking, strong MIS for reporting, monitoring and controlling risks, well laid out procedures, effective control and comprehensive risk reporting framework, separate risk management organization/framework independent of operational departments, and periodic review and evaluation.
Understanding the structure of risk management
- After analysing its risks and risk-bearing capabilities, each bank should set risk limitations.
- An impartial Risk Management Committee is tasked with managing risks generally at the organisational level.
- The goal of this high-level committee is to provide one group complete authority over assessing the bank’s total risks and choosing the amount of risk that will serve the bank’s interests.
- Identification, monitoring, and measurement of the bank’s risk profile are the main duties of the risk management committee.
- The committee also creates policies and processes, validates the pricing models for complicated items, evaluates risk models in light of market evolution, and also spots new dangers.
Loan review mechanism
- It is a useful instrument for continuously assessing the loan book’s quality and for bringing forth qualitative advancements in credit management.
- Banks have employed LRM for big-value accounts, with tasks allocated in areas such as analysing the portfolio’s quality, ensuring the integrity of the credit grading process, and monitoring the efficiency of loan administration.
- One of the fundamental elements of a successful LRM is accurate and fast credit grading.
Types of Risk in a banking system
|Credit risk||Market risk||Operational risk||Legal risk|
|Credit risk is the potential for losses due to a decrease in credit quality.
Credit risk arises from a bank’s dealings with individuals, corporations, banks, and sovereigns.
It may develop the following guise:
Treasury operations: The payment of counterparty payments may not be forthcoming.
Securities trading businesses: No effect on the funds and securities.
Cross-border exposure: Foreign currency transfers may be restricted by sovereigns.
Letters of credit or guarantees: When a responsibility crystallises, money might not be available.
Direct lending: No repayment of the principal and interest amount.
|Arise from adverse market risks like interest rate or equity price etc.
Small variations can bring considerable change in the income and economic value of the banks.
The following guises may develop as market risk:
Interest rate risk
Foreign exchange rate (forex) risk
Commodity price risk
Equity price risk
|Breakdown in internal controls and corporate governance can lead to financial loss through error, fraud, or failure to perform promptly, compromising the bank’s interests.||Legal risk includes fines, penalties, and damages.|
The Basel Norms for Banking are norms created by the Basel Committee on Banking to protect against the risk of default and ensure financial stability and common standards of banking regulations. They are housed in the BIS offices in Basel, Switzerland, and have been released by the Bureau of International Settlement (BIS).
The central bank governors of a group of ten countries established the Basel Committee on Banking Supervision (BCBS) in 1985. A group of banking supervisory authorities make up the BCBS. It regularly convenes in Basel’s Bank for International Settlements (BIS), which is located in Switzerland and houses its permanent secretariat.
|Basel I||Basel II||Basel III|
|The BCBS developed the 1988 Capital Accord to account for risk in assets and off-balance sheet business.||A reformed version of Basel I.||Basel III norms aim to make trading activities more capital-intensive and promote a more resilient banking system by focusing on four vital banking parameters: capital, leverage, funding and liquidity.|
|It’s entirely focused on credit risk.||The minimum capital adequacy requirement for banks should be 8% of risky assets.||Aims to Boost the banking industry’s resilience to shocks through governance, risk management, and transparency.
disclosure and market control
|Under the system, balance sheet assets, non-funded items and other off-balance sheet exposures are assigned weights and banks must maintain minimum capital funds equivalent to the prescribed ratio.||Banks must voluntarily submit to the central bank information about their risk exposure.||Basel III focussed on the following key pillars:
Pillar I: Increased minimum capital and liquidity requirements make up Pillar I.
Pillar II: Improved capital planning and risk management across the entire company
Pillar III: Improved risk
|Maintenance is based on risk-weighted assets, minimum capital funds, and ongoing basis.||It took three pillar approach
Pillar I: Minimum capital requirement:
Pillar II: Supervisory Review:
Pillar III: Market Discipline
1. The Basel III accord raised the minimum capital requirements for banks from 2% to 4.5% of common equity as a percentage of their risk-weighted assets.
2. Basel III introduced a non-risk-based leverage ratio to serve as a backstop to the risk-based capital requirements. Banks are required to hold a leverage ratio of over 3%.
3. The Liquidity Coverage Ratio and the Net Stable Funding Ratio are two liquidity ratios that were made available by Basel III.
Banks must have enough liquid assets to support a 30-day stressed financing scenario.
|Risk-adjusted assets are a weighted aggregate of funded and non-funded items.|
|The minimum requirement of capital funds is fixed at 8% of risk-weighted assets.
However, In India banks must maintain a CRAR of 9% on an ongoing basis.
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